Balancing the Balance of Payment

What is the issue?

New RBI data on India’s Balance of Payments for 2017-18 was released recently.
With CAD expected to widen, it is essential to assess the overall Balance of Payments (BoP) position of India.

What does the data reveal?

Forex - India’s forex reserves stands at around $424 billion as on March 2018.
This is actually the eighth largest in the world.

What does it imply?

What then is the concern?

Countries generally accumulate reserves by exporting more than importing.
IMF data on the current account balances reveals this nature.
Top 10 forex reserves holders have been running surpluses year after year.
This is however barring India and Brazil.
India has always had deficits on its merchandise trade account.
Its value of imports of goods is far in excess of that of exports.
However, India has traditionally enjoyed a surplus on its ‘invisibles’ account.
Invisibles basically cover receipts from export of software services.
Inward remittances by migrant workers, and tourism also form part of this.
On the other side, it includes payments towards interest, dividend and royalty on foreign loans, investments and technology/brands.
Besides it includes payments on banking, insurance and shipping services.
However, invisibles surpluses have not largely exceeded trade deficits.
This has resulted in the country consistently registering CADs.

How has India been managing this deficit?

India and Brazil represent unique cases of economies that have built reserves.
This was largely on the strength of the capital rather than current account of the BoP.
Thus, India has been managing these years with CADs, and still accumulating reserves.
This is because foreign exchange comes not only from exporting but also from capital flows.
It could be by way of foreign investment, commercial borrowings or external assistance.
For most years, net capital flows into India have been more than CADs.
The surplus capital flows have, then, gone into building reserves.

Is this a sustainable model?

It is to be noted that there have also been years with reserves depletion.
This was due to net capital inflows not being adequate to fund even the CAD.
Expecting foreign capital to bridge the gap between exports and imports would not be ideal.

How does the future look?

CAD - The CAD fell sharply from 2012-13 to 2016-17.
This was mainly because of India’s oil import bill nearly halving.
However, in 2017-18, the CAD has risen due to resurgent global crude prices.
Furthermore, CAD is expected to cross $75 billion this fiscal.
Inflows - There are signs of capital flows slowing down as well.
Foreign portfolio investment in India also reflects the larger sell-off pattern across emerging market economies.
This is primarily in response to profitable rising interest rates in the US.
The Swiss investment bank Credit Suisse's has forecasted on net capital flows to India for 2018-19.
Being $55 bn, it is far lower than the projected CAD of $75 bn.
Reserves - Eventually, forex reserves may decline for the first time since 2011-12.
The RBI’s data already show the total official reserves as in June at $413.11 bn.
This is a dip of around $ 11 bn over the level of end-March 2018.

How to deal with it?

Favourable growth prospects are essential to attract capital flows to fund CADs.
The investment environment of the country should also be conducive.
Notably, it is better if these investments go towards augmenting the economy’s manufacturing and services export capacities.
This, instead of simply producing or even importing for the domestic market, would be better.
In the long run, this can help narrow the CAD to more sustainable levels.

Source: Indian Express